Emerging Markets: PR is on the Upswing

Nick Niziolek

May 28, 2014

In early March, I wrote a post titled "Emerging Markets Should Fire Their PR Firms," which focused on some of the positive trends that seemed to be getting lost in the emerging market (EM) sell-off. The tide has since turned, and there has been a strong reversal in both news flows from and equity flows into EMs. Headlines have transitioned from "Currency Crisis" to "Modi Wins," and Russian equities have moved above the levels seen since before the Ukraine crisis began.

After falling more than 8% from the beginning of the year through early February, the MSCI Emerging Markets Index has staged a strong comeback. From March 20 through May 23, the index has risen more than 11%, outperforming the S&P 500 Index by nearly 1000 basis points and the MSCI World Index by more than 800 basis points. Year to date, the MSCI Emerging Markets Index has returned nearly 5%, outperforming both indexes by more than 100 basis points.

Moreover, we’ve identified several near-term catalysts that could further support the equity breakout that is underway. Prime Minister Modi’s victory in India has dominated recent headlines, but the Indonesian Presidential election scheduled for early July could serve as a similarly significant positive catalyst for the world’s sixteenth largest economy. Frontrunner Joko Widodo has campaigned on a platform of education, energy, infrastructure, and bureaucratic reforms. His ability to rapidly implement changes as mayor of Surakarta has fueled optimism that he can successfully move forward reforms on a national scale in short order.

Only in EM investing could a military coup be viewed as a potentially beneficial catalyst, but recent developments in Thailand are shining a new light on the risks and opportunities within that country. While Thailand is unlikely to grab favorable headlines in upcoming weeks, the resolution of regional political conflicts could provide a catalyst for Thailand. We have very little exposure to Thailand currently, but there may be an opportunity later this year to increase our exposure, given our view that the new government will look to rapidly roll out stimulus measures to support the political transition.

Although the breakout in EM equities has had good breadth, there have been laggards, including China and Mexico, both of which outperformed during 2013. We have a constructive top-down view of both countries, and are taking advantage of recent weakness by adding to our favorite positions. While the world focuses on reform prospects in India and Indonesia, Mexico is further along, with promising signs of continued momentum. Mexico recently increased its infrastructure spending target to $587 billion by 2018, more than twice the target President Pena Nieto announced in July of 2013 and the equivalent of nearly 50% of Mexico’s annual GDP. This new figure includes $362 billion in public spending and is 71% higher than what the previous administration achieved. Project awards are only now beginning to ramp up, with many construction projects expected to begin later this year, which should provide additional tailwinds for this economy. Meanwhile, we still see significant opportunity within China as it navigates a soft-landing and advances reforms that should further open the economy and encourage private investment.

Despite the good news coming from many countries, investors should remain prepared for pockets of negative news and the volatility inherent in EM investing. For example, we remain cautious on Russia. Even if tensions de-escalate in Ukraine, recent events highlight the ongoing power struggles between Russia and the West that are playing out in many former Soviet states. Our research team was in Moscow several weeks ago and noted that there were no signs of stress within Moscow due to Ukrainian developments, with public approval ratings and nationalism at all-time highs. While we cannot predict Putin’s next move, we must factor in downside risks when evaluating investments in this region relative to the opportunities we are seeing in more stable emerging markets.

While the market has looked past the near-term fiscal and economic challenges within Brazil, due in part to optimism about upcoming elections, we remain cautious as we have not seen a candidate put forth the slate of reforms we believe are needed to foster a stronger recovery. In this environment, we’re continuing to seek out bottom-up growth opportunities that can do well with a less favorable economic backdrop.

We have been pleased to see more positive headlines coming out of the EMs over these past weeks, with equity flows and returns fueling near-term optimism. We expect additional bouts of volatility, but we believe this will create opportunities given the long-term growth potential of emerging markets and several near-term catalysts that can provide additional positive news flows. We have used the market upswing to realize gains in countries and companies that we believe may have risen too far of late, reallocating capital in some of our more favored countries that have lagged during the initial stages of this rally. As always, we are taking advantage of the inefficiencies that we believe are created by passively managed exchange-traded EM funds. We encourage our clients to not try to time these rallies and corrections, but instead remain invested for the long-term potential that EM equities provide.

The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.

The information in this report should not be considered a recommendation to purchase or sell any particular security. The views and strategies described may not be suitable for all investors. As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.

The MSCI World Index is a benchmark of developed equity market performance; the MSCI Emerging Market Index is a benchmark for the performance of emerging market equities and the S&P 500 Index is a commonly cited gauge of U.S. large-cap equity market performance. Indexes are unmanaged, are unavailable for direct investment and do not include fees or expenses.

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